Category Archives: Investing Money

Stock Pickers vs Indexers

My Comments: Which approach is best for you? Not for me, but for YOU?

For the past dozen years or more, my efforts on behalf of clients to use historically good fund managers has largely failed. And not just because of what happened in 2008-09.

Yes, I still made my money as an advisor. But increasingly I couldn’t justify it in terms of the results. Many clients, listening to the likes of Jim Cramer on TV, decided they could get better results elsewhere. I hope they were successful but the odds were not in their favor. If you follow the link below, you’ll better understand why I say this.

My approach today is to use one of the two major global index families and either give away my advice to those who will accept it, or charge what a few years ago was considered a ridiculously low fee. Some people just have absolutely no capacity to figure it out for themselves which is what gives people like me a license earn an income.

Clients have two basic choices: either do it all yourself, of find someone to help you. Regardless of that decision, the next step on the decision tree is how much unprotected exposure to the stock, bond and other markets can you live with.

The trauma from the crash in 2008-09 is still very much alive in peoples minds. To the extent you want exposure to the markets and at the same time protect your downside, there are some very clear solutions. To the extent you are OK with watching your assets crash and burn, indexes at least eliminate most of the management costs. This is a good thing.

Either way, I can sleep at night and not feel like caveat emptor is the ruling maxim.

Why Reducing Investment Losses Is So Important

My Comments: There are times to be cautious and there are times to throw caution to the winds. As you get older, caution is increasingly common.

One way to solve your dilemma is to focus efforts on limiting what we call downside risk. That’s the opposite of upside risk for those of you just figuring this out. Most people have no problem with the upside. I’ve never had a client pissed at me for helping them make a lot of money.

However, for the past two plus years, it’s been elusive. There is a remedy but first, let’s set the stage for controlling downside risk. This idea become increasingly critical in retirement when you start using your retirement savings to pay bills.

Raul Elizalde  |  April 6, 2017

Investing in stocks can be brutal. According to research, the S&P 500 lost at least 10% from a previous high every two-and-a-half years on average, and at least 20% every six. A 30% loss happened every 13. It has fallen 50% from a peak three times since 1954. Remarkably, losses of this magnitude contradict the models we use to describe market behavior.

For example, the largest S&P 500 one-day loss was 20.5% in October 1987. According to a widely used model of stock market returns (which assumes they form a bell curve around an average), the likelihood of the 1987 loss is roughly equivalent to picking the right card in a deck with as many cards as atoms in the known universe. In other words, that loss could not have happened.

Limit Your Losses When the Market Drops

Clearly the problem is not that impossible events happen; it is rather that our models are inadequate, and a lot of analysts have tried to come up with better ones. So far, this quest has proven fruitless. We still can’t predict markets with any meaningful accuracy. This is why markets are not so much like the weather, but rather like earthquakes, which scientists now admit are unpredictable.

But here is the good news: we cannot predict earthquakes, but we know how to build earthquake-resistant structures. Likewise, we cannot predict markets, but we have techniques that can help us limit losses when markets tank. There are some very basic reasons why limiting losses is more important than producing strong returns.

A well-known example goes like this: If you lose 50% of $100 you need a 100% return on the remaining $50 to break even. This means that a large percentage loss requires a very large percentage gain for full recovery.

But a far more important example is this: If you only lose 20% of $100, you will need just 25% to bring the remaining $80 back to $100. So a small loss requires much less effort to come out from it.
Limiting Losses Even More Important in Retirement

This is even more important for retirees who use savings to pay for living expenses.

For example, taking $10 after a portfolio falls from $100 to $50 leaves the saver with only $40. A subsequent 100% return only takes the portfolio back to $80. That means that the $10 withdrawal turned into $20 because of its bad timing.

But when $100 only falls to $80 and $10 are taken, a subsequent 25% recovery on the remaining $70 brings the value up to $87.50. This means that the $10 withdrawal turned into $12.50—a much smaller penalty for taking money out at the worst possible time.

The moral is clear: limiting losses is an essential element in portfolio management.

How to Limit Losses

Limiting losses requires some basic processes in place. The best known is diversification, or investing in a mix of assets that tend to move in different directions. But a mix that looks diversified today may not be diversified tomorrow, especially when markets take a turn for the worse. This is because in down markets investors sell everything and correlations go up sharply. Therefore, a mix that does not take into account how the market cycle changes is prone to go through periods where diversification goes away just when investors need it most. Adapting portfolios to market conditions requires dedication, patience, and a well-designed set of rules.

This is, or should be, the professional portfolio manager’s job. Some investors insist that the portfolio manager’s job is simply to beat the market by picking a high proportion of winning assets. Accordingly, they are willing to pay a premium for those managers who seem to have the hot hands. This is a bad approach, commonly known as “chasing past returns.”
Many studies show that virtually no active fund can consistently beat its benchmark, and not because of fees. According to Standard & Poor, which publishes a regular analysis of fund performance, most funds underperform their benchmarks both before and after fees.

The simple explanation is that poorly diversified funds can only outperform their benchmarks through superior forecasting. But, just like for earthquakes, forecasting the market accurately is impossible. As one academic put it:

Going back to basics, the idea “to invest successfully in the stock market, you need to know whether the market is going to go up or go down” is just wrong. (Professor David Aldous, UC Berkeley – The Kelly criterion for favorable games, Lecture 2)

While limiting downside exposure is crucial in portfolio management, having this protection in place at all times can be frustrating. If the market keeps on rallying, the “insurance” against declines may appear to be an unnecessary drag on returns, just as going through the expense of building a house that is earthquake-resistant may seem like a waste as long as there are no earthquakes.

We have all complained about paying for insurance that we don’t seem to need. This is understandable as long as disaster does not strike. But the temptation to cancel insurance can be dangerous. If you are not yet convinced this is so, please reread the first paragraph to see why having a systematic process to protect investments from losses is a good idea.

The Best Way to Invest in Index Funds

My Comments: It’s important that some of your money be exposed to the risks and rewards of the stock and bond markets. Not all your money, perhaps 25% of it.

So what’s the next step? There’s an increasing awareness of fees and commissions and how they have the potential to erode the value of your holdings over the years. If someone is adding value to your life, it’s appropriate they be compensated fairly. The challenge is to determine what is fair.

Index funds are among the most cost effective choices to build a well diversified portfolio. Many of us have the ability to be passive investors, even stepping up our game from time to time to be active investors. If you need help beyond that, look for someone willing to do it for you for about ½ of 1% per year.

Nellie S. Huang / February 2017 / Kiplinger

Investors’ passion for indexing these days reminds us of a classic Cole Porter lyric: “Birds do it, bees do it, even educated fleas do it.” Yep, everybody, it seems, is falling in love—with index funds. Since 2010, investors have withdrawn a net sum of $500 billion from actively managed U.S. stock funds and invested that amount and more in index-tracking mutual funds and exchange-traded funds. But one of the cardinal rules of investing is that whenever everyone agrees on something, chances are high that just the opposite will occur. So could indexing be the wrong way to go?

The answer: yes and no. The benefits of indexing are indisputable—the strategy is cheap, it’s transparent, and it’s no-fuss (once you’ve decided which benchmarks you want to track). And in recent years, indexing has worked particularly well with the world’s most widely mimicked benchmark, Standard & Poor’s 500-stock index. Over the past five years, the S&P 500 generated a cumulative gain of 98% (14.7% annualized). During that period, only 14% of actively managed, large-company mutual funds beat the index. (All returns are through December 31.)

But indexing has its shortcomings, too. It’s not as effective in some categories as it is for large-capitalization U.S. stocks. If you index, you cannot beat the market; actively run funds at least give you the chance to outpace a benchmark. Plus, says Daniel Wiener, editor of the Independent Adviser for Vanguard Investors newsletter, “good timing” is required even in indexing. In particular, this may not be the best time to hitch your wagon to the S&P 500, which is what many people think about when they consider indexing. Indexing’s defenders may scoff, but there have been times—long stretches, even—when active managers dominated their benchmarks.

In the end, your best strategy may be to own a combination of index and actively managed funds. Choosing good active funds is key, of course. The other trick is knowing which markets or market segments are best suited to indexing, and in which slices active funds stand a better chance of winning. Below, we tell you where to index and where to go active.

The indexing advantage

The price is right. Index funds buy and sell securities less frequently than actively managed funds, so they incur fewer trading costs. More important, index funds charge substantially lower fees. The expense ratio for the typical actively managed large-company stock mutual fund is 1.13%. But mutual funds and ETFs that track large-cap U.S. stock indexes cost 0.49%, on average, and many charge far less.

3 Charts That Show Stock Market Euphoria Is Totally Unprecedented

My Comments: I’m thinking of getting into the markets. That’s a sure sign the bottom will soon drop out.

Jesse Felder on March 18, 2017

Last week I focused on fundamentals, sharing 3 charts that show stock market valuations are totally unprecedented. This week I’ll focus on sentiment.

When looking at sentiment many people like to look at surveys. I prefer to look at what people are actually doing with their money. It’s a fact that we are now seeing record inflows into the equity markets but how do we put this into context?

First, I would just note that Rydex traders have been a good contrarian indicator for a long time. They recently positioned themselves more bullishly than any time in the history of this fund family, even surpassing the peak seen during the height of the dotcom mania.

I also like to look at margin debt, or total borrowing in brokerage accounts, as way of assessing speculative fervor. Nominal margin debt recently hit a new record high but I prefer to normalize this measure by comparing it to the size of the economy. This adjusted measure also recently hit a new, all-time high greater than that set in 2000.

Finally, we can look at household financial assets invested in the stock market compared to those in money market funds. Here is where we see the direct result of 7 years of zero percent interest rate policy. Households now have more than 15 times as much money invested in stocks than they do in money market funds, well beyond anything we have seen since the invention of these cash vehicles.

With as much money as they are now pouring into the equity markets, investors might do well to remember that bull markets aren’t born on euphoria.

Source: http://seekingalpha.com/article/4056252-3-charts-show-stock-market-euphoria-totally-unprecedented

Investment Test

moneyMy Comments: I have no idea where the following came from. I found them in my archives and decided the respective statements and explanation are still very relevant. And besides, today is Monday and that’s when I post stuff about investing money. My apologies for not being able to correctly attribute this post.

Which investment has the highest average annual returns, historically?

Since 1978, according to Morningstar, stocks have returned an average annual 11.6%, compared with 11.1% for real estate, 8.9% for bonds and just 5.2% for the shiny yellow metal.

When yields go down, bond prices go up.

If market interest rates fall, which means new bonds will be issued with lower yields, the prices of outstanding bonds will rise. It’s simple supply and demand. Say you purchase a $10,000, 10-year bond with a 2% yield. That gives you $200 a year in interest. Now imagine that rates fall and new 10-years are issued at 1%. A buyer can choose between your bond, yielding 2% and paying $200 annually, or a new bond paying just $100 a year. Naturally, your bond will command a premium price in the secondary market. Similarly, if new bonds are yielding 3%, your 2% bond will become less attractive and will have to sell at a discount to attract any interest. So while the yield of your bond remains fixed for the life of the security, the market will adjust the price you can get for it to reflect current market rates.

The higher the yield on a dividend-paying stock, the safer the investment.

In fact, the opposite might be the case. Find the yield by dividing the stock’s dividend per share by the share price. If the high yield reflects an overly generous dividend, you have to ask yourself whether the company has the cash to sustain it. Look for a positive free cash flow, which means a company has invested what it needs to maintain its business and has money left over to spend on dividends. Another measure is the stock’s payout ratio—the percentage of earnings paid out in dividends. The average payout ratio for the S&P 500 has been around 40% recently. A spiking yield likely indicates a sinking stock price. That’s a red flag that demands further investigation.

A company’s market capitalization is calculated by multiplying the stock price by the number of shares outstanding.

Although definitions vary, so-called large-capitalization stocks are generally considered to be those with a market value of $5 billion or more; mid-cap stocks fall within the $2 billion to $5 billion range; and small-cap stocks are classified as those with a market value of less than $2 billion. Slicing and dicing a little further gets you mega-caps, at $100 billion or more, and micro-caps, at $50 million to $300 million.

Stocks aren’t in a bear market until they lose 20% of their value.

The classic definition of a bear market is a 20% decline from the previous peak, although the average loss suffered in 13 bear markets since 1929 is nearly 40%, measured by losses in Standard & Poor’s 500-stock index (not including dividends). A stock market “correction” is generally considered to be a pullback of at least 10%. Since World War II, there have been 11 bear markets and 21 corrections.

The best time to buy stocks is at the start of an economic expansion. The best time to sell is when there’s a recession.

The stock market anticipates the economy, not the other way around, typically by six to nine months. By the time you know there’s a recession, your portfolio has most likely already taken a big hit, and by the time a recession is pronounced over, stocks have usually been off to the races for a while. The Great Recession began in December 2007, according to the National Bureau of Economic Research, the official arbiter of recessions and expansions. But stocks had already peaked in October. And if you missed the start of the bull market on March 9, 2009, because you were waiting for the recession’s end, which came in June of that year, you’d have missed a 64% rally.

A stock with a low price-earnings ratio is always a better bargain than a stock with a high P/E.

Context matters with P/Es, which are calculated by dividing a company’s stock price by its earnings per share, often estimated for the coming 12 months. What’s high for a mature utility company could be low for a fast-growing tech stock, for example. Stocks in the utilities and tech sectors recently sported average P/Es of 18 and 17, respectively. Based on historical norms, that implied that utilities were overvalued by 19%, while tech stocks were 17% undervalued. In the same way, analysts at S&P Global recently considered biotech drugmaker Regeneron Pharmaceuticals, with a P/E approaching 25, to be a better buy than blue-chip pharmaceutical firm Pfizer, with a P/E of 12. P/Es are most useful when comparing a company with its peer group, or comparing an industry with its long-term average.

A strategy that calls for investing a fixed amount at regular intervals is known as:

Dollar-cost averaging can lower the average cost of shares because you are spreading out your purchases, hopefully buying more when prices are lower and fewer when prices are high. If you invest all of your money at once, rather than at regular intervals, you might get unlucky and buy the stock at or near its peak price.

The strategy also helps curb harmful behavioral inclinations. If you’re apprehensive about investing, dollar-cost averaging makes it easier to take the plunge by spreading your risk over an extended period. Once you’re in the market, the strategy can help you stick to your plan. Putting everything into the market at once guarantees that you’ll know all too well how much you’ve lost if you happen to invest at the wrong time. Investing at intervals erases that fixed reference point, making it easier to keep your cool.

How many companies in Standard & Poor’s 500-stock index have a triple-A credit rating?

Microsoft and Johnson & Johnson are the only companies to sport Standard & Poor’s highest rating, after ExxonMobil lost its AAA rating in April 2016. In 1980, 32 S&P 500 companies carried the coveted triple-A rating. Apple, which has the largest weight in the S&P index, has an AA+ rating.

In investing, the pleasure of making money trumps the pain of losing.

Investors feel the pain of a loss about twice as much as they feel the pleasure of the same-size gain, say market behavior psychologists. This loss aversion can contribute to a number of investing mistakes. Investors who fear a loss, and especially those who have recently suffered one, can be reluctant to take risks that are entirely appropriate. For example, many investors shunned the stock market after the 2007-09 financial crisis, missing out on significant gains. Loss aversion can also cause an investor to sell what should be a long-term holding too soon, after a short-term hiccup. Conversely, an investor might hold on to a losing investment too long, reluctant to lock in the loss.

Investment Strategies for Your Retirement Accounts

InvestMy Comments: A phrase I’m known to use from time to time is that ‘life is generally better with more money than it is with less money.” While this might seem obvious, there are many people whose efforts to have more money have fallen flat. Here’s a few ideas that might help you.

Michelle Mabry, CFP®, AIF® January 26, 2017

With interest rates coming off a 36-year low and expected to rise, most investors expect to see bond prices fall and consequently deliver a negative return in what is considered a low-risk asset. We have seen a rebound in equities, and with the S&P 500 and Dow at all-time highs, some say the stock market is richly valued. As a retiree seeking income from your investments and looking to preserve your principal, where can you turn? What are ways retirees can invest for income and still minimize risk?

You have always heard you need a diversified portfolio and that has not changed, but what has changed is how you diversify it. Retirees need to determine the proper asset allocation of stocks, bonds, cash and alternatives based on income needs, time frame, and tolerance for risk.

How to Diversify Investments in Retirement

Let’s look at bonds first. If you invest in a traditional bond portfolio you are exposing yourself to interest-rate risk as rates rise and bond prices fall. You need to understand the average duration of the bond investments you hold. For example, a typical intermediate-term bond fund will have a duration of 5-10 years. If the average duration is eight years, then a 1% increase in rates will result in an 8% decrease in the net asset value (NAV). This would wipe out all the interest gains and then some. The shorter the duration, the less the potential loss.

So it is important to look for other assets that have low-risk characteristics or standard deviation similar to bonds but produce absolute returns, that is, a positive return regardless of which way rates are moving. Floating rate income, TIPs and some market neutral funds can be a good way to diversify your fixed-income portfolio. You may also want to look at structured notes as a way to produce yield and protect your downside.

Dividends as Equity

For the equity portion of your retirement portfolio, consider blue chip dividend-paying stocks or dividend growth strategies. Many large-cap funds pay dividends in excess of 2.5%, plus you have the upside appreciation potential over time to keep pace with inflation during your retirement years. Remember to keep focused on the longer term and not be too concerned with short-term volatility. Dividend-paying stocks have outperformed most other asset classes over time. Small-cap stocks have been one of the best-performing asset classes, so it would make sense to find dividend-paying small- and mid-cap equities as well.

When searching the universe of mutual funds and ETFs, there are not many of these, but a couple that have attracted our attention are WisdomTree Midcap Dividend Fund and WisdomTree Small Cap Dividend Fund with yields of 2.63% and 3.03% respectively as of December 30, 2016. Of close to 2,000 ETFs available in the U.S., a search revealed only four that are exclusively dividend-driven and which also hold just domestic small- or mid-cap stocks. Two of the portfolios feature issues that have exhibited dividend growth while the other two ETFs (the WisdomTree funds) include all dividend payers in their capitalization range.

Include Alternative Assets for Diversification

Also important in developing a portfolio for retirement is a focus on absolute return strategies, and many of these fall into the alternative asset class. Alternatives are anything that is not a stock, bond or cash. Alternatives have no correlation or negative correlation to other asset classes so they are great diversifiers. Our retired clients typically have one-third of their portfolio in alternatives. Examples include managed futures and long/short strategies as well as volatility strategies using options. An example is LJM Preservation and Growth which has shown a positive return every year since its inception 10 years ago with the exception of one year, 2013, when the stock market went straight up and there really was no volatility. The fund was up in 2008 when stocks and bonds were not, and therein lies the importance of a diversified portfolio to manage risk.

By rebalancing your investments quarterly or semi-annually back to the original investment allocations you can create the cash needed to sustain your monthly withdrawals in retirement until the next rebalance. We do not recommend a withdrawal rate in excess of 4% in light of current market and economic conditions.

Stock Manager of $37 Billion Doesn’t Believe the Earnings Hype

roller coaster2My Comments: Monday, post #2.

First, you don’t get to manage $37B unless you know what the hell you are doing.

Two, the higher we go, the harder will be the fall. Put a lot of your money in cash and keep it there until the dust settles.

by Jonas Cho Walsgard / February 19, 2017

Global stock investors may have their hopes set too high for 2017.

With rising stock prices, analysts may need to dial back their expectations with companies missing earnings growth estimates posing the biggest risk to equity markets, according to Robert Naess, who manages 35 billion euros ($37 billion) in stocks at Nordea Bank AB, Scandinavia’s largest bank.

“There’s too much optimism,” he said in an interview in Oslo on Wednesday. “It’s definitely too high. I’m pretty sure I’ll be right.”

Stocks have rallied amid signs of stabilization in China’s economy and bets that President Donald Trump will boost U.S. infrastructure spending, roll back regulations and cut taxes. The Standard and Poor’s 500 Index has risen 28 percent since hitting a low in February last year pushing up price to earnings to more than 21 times, the highest since 2009. Positive earnings per share growth is estimated at 15 percent for the S&P 500, according to data compiled by Bloomberg.

“This indicates that it’s a bit expensive,” the 52-year-old said.

Investors shouldn’t be fooled by top line sales growth as profitability is set to be squeezed by rising wages amid declining unemployment, the fund manager said. With margins already high, corporate earnings estimates will have to come down, he said.

Naess and his partner Claus Vorm quantitatively analyze thousands of companies to build a portfolio of about 100 “boring” stocks. They invest in companies with the most stable earnings and avoid expensive stocks, a strategy which delivered an 11 percent return for the Global Stable Equity Fund in 2016. It has returned 16 percent on average in the past five years, beating 96 percent of its peers.

The fund this year has boosted its stake in EBay Inc. while its biggest increases last year included Walgreens Boots Alliance Inc., Walt Disney Co., Verizon Communications Inc. and Apple Inc.

“It’s always better to have stable equities,” Naess said. “Long term you will get better returns. Good companies continue to be good. More cyclical companies have a tendency to stumble now and then.”

And while investors could be overestimating future company earnings, they may also be putting “too little weight” on potential risks from U.S. policy changes by President Donald Trump, such as potential trade conflicts, Naess said.

“There’s still risk with Trump even if the market receives it very positively,” he said. “There’s more risk now than before. The outcome range with Trump is wider.”